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Create a Money Machine: The Effect of Compounding

If you're not investing yet, read on and let us convince you to start now.

In 1991, at the age of 38, we left the conventional working world and began to journey around the globe. Self-funded from our retirement investments, we travel slowly and have seen many countries and native cultures firsthand.

Our adventures around the world allow us to interact with many younger travelers in cafes and restaurants. Travelers are a great source of information about the places they've visited, such as the best places to stay, areas to avoid, and the most efficient ways to get around.

People often ask us how we can afford to travel for so long, and they often say wistfully, "I wish I could do what you're doing."

That's when I tell them that they can.

I explain in simple terms how they can invest and create their own pension or annuity -- or, as I like to call it, a "personal money machine." This is the point when their eyes usually glaze over like they're trapped in a conversation with their crazy uncle at Thanksgiving Dinner.

So I get their attention back by saying they have a powerful weapon in their arsenal that we lack: time. I ask whether they know what "compounding" is. More often than not, they have no clue. These are college grads or current students who are taking a break from school to cure their traveling bug. Many are not yet familiar with the concept of compounding, which, in my opinion, is the easiest way to build wealth.

According to Investopedia, the definition of compounding is "the ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings."

Bingo! A remarkably simple recipe for long-term financial security.

The earlier these "kids" start investing, the sooner they'll achieve financial independence -- and the more they'll be able to live it up in retirement. Time is on their side. It takes very little effort to open an online brokerage account and buy shares in exchange-traded funds like the Vanguard Total Stock Market ETF or the SPDR S&P 500 ETF. By owning these, you participate in the growth of the largest companies in the U.S., and you can invest in them through a tax-advantaged IRA or sometimes even through a 401(k) if your employer offers one. The fees to purchase shares have never been lower, and investing has never been more convenient.

Since the early 1950s, when I was born, the average annual return of the benchmark S&P 500 Index has been 12.41% through the end of 2014. Over that time period, each dollar invested in the index grew to $683, which is a fantastic return on money that's doing all the work for you, the investor. Imagine if my parents had invested $1,000 in my name the year I was born. It would be worth $683,000 today without my adding another cent. Amazing! Your mileage may vary, but the important thing is for this younger generation to get started now and take advantage of the power of compounding.

We created our own money machine before we retired early in 1991, and we were 38 at the time -- older than these young travelers we encounter in our travels. Yet we knew we still had many years for our investments to grow, thereby allowing the market to work for us while we traveled the globe.

The compounding effect on early in-life investments will pay you dividends far into the future and can become a solid foundation for retirement. If I could convince young people of one thing, it would be to start investing now.